Dangerous Words

One of the causes of the Financial Crisis that is sometimes cited is an inappropriate reliance on complex financial models.  In our defense, risk managers have often said that users did not take the time to understand the models that they relied upon.

And I have said that in some sense, blaming the bad decisions on the models is like a driver who gets lost blaming it on the car.

But we risk managers and risk modelers do need to be careful with the words that we use.  Some of the most common risk management terminology is guilty of being totally misleading to someone who has no risk management training – who simply relies upon their understanding of English.

One of the fundamental steps of risk management is to MEASURE RISK.

I would suggest that this very common term is potentially misleading and risk managers should consider using it less.

In common usage, you could say that you measure a distance between two points or measure the weight of an object.  Measurement usually refers to something completely objective.

However, when we “measure” risk, it is not at all objective.  That is because Risk is actually about the future.  We cannot measure the future.  Or any specific aspect of the future.

While I can measure my height and weight today, I cannot now measure what it will be tomorrow.  I can predict what it might be tomorrow.  I might be pretty certain of a fairly tight range of values, but that does not make my prediction into a measurement.

So by the very words we use to describe what we are doing, we sought to instill a degree of certainty and reliability that is impossible and unwarranted.  We did that perhaps as mathematicians who are used to starting a problem by defining terms.  So we start our work by defining our calculation as a “measurement” of risk.

However, non-mathematicians are not so used to defining A = B at the start of the day and then remembering thereafter that whenever they hear someone refer to A, that they really mean B.

We also may have defined our work as “measuring risk” to instill in it enough confidence from the users that they would actually pay attention to the work and rely upon it.  In which case we are not quite as innocent as we might claim on the over reliance front.

It might be difficult now to retreat however.  Try telling management that you do not now, not have you ever measured risk.  And see what happens to your budget.

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Explore posts in the same categories: Assumptions, Disclosure, Modeling, risk assessment

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